After five years of studying the global development of virtual currencies (VC), the Reserve Bank of India (RBI) in April 2018 issued a circular under the Banking Regulation Act, 1949 (BRA), the Reserve Bank of India Act, 1934 (RBI Act) and the Payment and Settlement Systems Act, 2007, directing entities regulated by it not to deal in VCs or to provide services that facilitated dealings in VCs. The circular was challenged in the Supreme Court in Internet and Mobile Association of India v Reserve Bank of India.
The petitioner contended that VCs are tradable commodities or digital goods and not legal tender, and therefore do not fall within the credit system. The RBI thus had no power to regulate them. The court noted that among other functions, the RBI was empowered to operate the currency and credit system and to regulate and supervise credit and payment networks for the benefit of that system. It was the nature of VCs that determined if the RBI could regulate them.
Although both parties agreed that VCs are not legal tender, the RBI argued that it could regulate them as they were capable of being used as a medium of exchange. Regulators and governments around the world had agreed that VCs had not acquired the status of legal tender but that they were digital representations of value, used as a medium of exchange. Courts in disparate jurisdictions, however, had ruled in different ways and had variously recognized VCs as properties or commodities, or non-traditional currency or payment instruments.
The court noted that being legal tender does not alone constitute money. The Foreign Exchange Management Act, 1999, defines currency to include promissory notes, cheques and bills of exchange, among others, which are strictly not currency, but can discharge debt. Similarly, Prize Chits and Money Circulation Schemes (Banning) Act, 1978, defines money to include cheques, postal orders, demand drafts, among others. The Finance Act, 1994, defines money to include legal tender, cheques, postal or electronic remittance, etc. Instruments other than legal tender are recognized as money as they can discharge debt, and are included in credit and payment systems. The RBI alone can regulate such systems and as VCs are valid payments for transactions, the RBI is able to regulate VCs.
The petitioner’s argument that the RBI could only regulate VCs and not prohibit them entirely, was rejected. Relying on an earlier judgement in the Star India (2019) case the court held that the power to regulate is broad and encompasses the power to prohibit. Further, the RBI has extensive powers and may frame enforcement policies and issue directions accordingly. Section 36(1)(a) of the BRA empowers the RBI to prohibit such classes of transactions as it determines. In any event, the circular did not prohibit the use or trading of VCs, but merely prohibited the provision of banking services to those engaged in the trading of VCs. The crippling of VC related activities does not amount to total prohibition.
The court also rejected the submission that the RBI had not applied its mind when issuing the circular. The RBI had engaged extensively on VCs, including interacting with the government regarding the regulation of crypto assets. The court disagreed with the argument that the RBI should not be included in a hands-off approach to legislate on economic matters. The RBI’s circulars are not strictly delegated legislation, but under the RBI Act and the BRA the RBI is intended to operate independently, even of the central government. Policy decisions of the RBI should therefore receive judicial deference.
The petitioner argued that banking channels are essential to businesses, especially in view of restrictions on cash transactions under the Income Tax Act, 1961. Any restriction, not shown to be reasonable under article 19(6) of the constitution, that impairs the right to carry on business, is in violation of a fundamental right contrary to article 19(1)(g). The court noted that the prohibition was intended to prevent money-laundering, curb terrorism financing and safeguard payment and credit systems, and that trading in VCs was not prohibited. VCs continue to be accepted as payment globally and domestically. However, VC exchanges alone were denied access to banking channels despite doing no wrong, and their right to carry on trade had been violated.
The court agreed that prohibiting access to banking channels was not a proportionate measure. In its earlier judgement in the State of Maharashtra (2013) case the court had ruled that empirical data would assist to determine the proportionality of a measure, but here entities regulated by the RBI had not suffered loss nor been adversely affected by VCs. Therefore, the circular was set aside for failing the proportionality test.
Karthik Somasundram and Sneha Jaisingh are partners at Bharucha & Partners.